It's wise to be very suspicious of richly-valued IPOs. History
has shown us time and again that many will end up stumbling badly
once they must prove themselves on a quarterly basis. Yet in the
early days of trading, these stocks are often accorded valuations
that lead you to think they may be the next
Google (Nasdaq:
GOOG
)
or
Amazon.com (Nasdaq:
AMZN
)
.
That's why I suggested you steer clear of
Zynga (Nasdaq:
ZNGA
)
and
Groupon (Nasdaq:
GRPN
)
when I
analyzed them
six months ago.
"These companies should grow at a fast pace in 2012, but their
stocks are quite vulnerable to the eventual, inevitable cool-down
in growth that all businesses see as they reach maturity," I said
back then. Sure enough, each stock now trades for roughly 80% less
than their peak from just a few quarters ago. To be sure, I
eventually suggestedshares of Zynga had likely found a floor around
$5 but they've since fallen to just $3.
I took a more benign view toward the third stock in the group,
LinkedIn (Nasdaq:
LNKD
)
. Whereas I thought Groupon and Zynga were mere flashes in the pan,
I noted that "At least LinkedIn has the feel of a real business
tool and not just a social fad," adding that because of the
automated nature of itsbusiness model , LinkedIn was positioned to
generate solidprofit margins as sales rise.
Still, I had never become fully convinced that LinkedIn has all
that much upside. Yes the company is growing quickly, but the
valuations remain quite stretched.
Now, I'm singing a different tune.
I think LinkedIn's stock is in factovervalued and ready to
tumble. Though the company has delivered several solid quarters
sincegoing public , early signs of maturity have kicked in, so it's
only a matter of time before investors realize that expectations of
stunningly robust perpetual growth will be hard to attain. The
stock's value in relation toearnings is another major hurdle to
overcome. One or both of these hurdles will likely cause this stock
to stumble.
Slowing growth?
To get a sense of LinkedIn's growth trajectory, you can track
quarter-to-growth rates. In coming quarters, this metric is looking
a lot more sobering.
.gif)
As you can see, LinkedIn has averaged roughly 17% sequential
sales growth in the past three quarters, yet that figure is
expected to slow to just 6% in the current quarter, and average 9%
in the final two quarters. You can see by the year-over-year
revenue growth rates that a clear deceleration has been underway
since the third quarter of 2011.
To be fair, LinkedIn managed to exceed second-quarter revenue
forecasts by roughly $11 million, so let's be generous and assume
the company beats top-line forecasts by the same amount in the
third and fourth quarters. You can stillspot a trend of
decelerating growth.
.gif)
Right now, analysts anticipate that LinkedIn will likely boost
sales about 50% in 2013, in large part because that's what the
company is publicly predicting. In other words, most analysts have
no clue. As we've seen with so many young high-growth companies,
there really is no way of knowing how far a long a company is in
terms ofmarket saturation -- until it happens. And this is a lesson
Groupon brought home this week with its earnings bombshell).
Even if LinkedIn boosts sales 50% in 2013, which equates to a
$460 million sequential revenue increase, it will become
significantly harder for LinkedIn to boost sales in 2014 at an even
40% clip. This equates to a $556 million increase in sales from
2013 levels. A target of 25% sales growth (or about $350 million)
seems more feasible for a company that will already have had five
years of awareness-building among potential clients under its
belt.
So using an assumption of 25% sales growth in 2014 and beyond,
and giving credit formargin leverage which shouldyield 35% earnings
growth per share, let's revisit what LinkedIn'sincome statement
might look like by mid-decade.
.gif)
When I looked at LinkedIn back in February, I saw a path to $2
inearnings per share (
EPS
) by 2016. A few strong quarters and some generous assumptions
later, and I'm now looking at $3 inEPS by then. Still, you need to
know that this stock, which is currently being snapped up because
of its high-growth characteristics, will eventually judged by its
earnings power.
And it's simply impossible to square a $100 stock with $3 in EPS
that is still four years away. Investors must always apply a
discount rate on future earnings to compensate for the risk that
earnings targets won't be achieved. So the truepresent value of
those 2016 projected profits is actually well lower. What's a
goodmultiple on 2016 profits? How about 20 or 25? That placesfair
value for this stock in the $65 to $80 range, which is well below
the recent $103.
Risks to Consider:
As an upside risk, a quick improvement in thejob market could
lead many more people to upgrade their visibility toward other
employers, and LinkedIn would likely play a key role in that
effort.
Action to Take -->
When I looked at LinkedIn early this year, I suggested it would be
harder for this stock to gain a richer multiple, limiting upside.
Now, in aneconomy that has markedly slowed since then, investors
have become much less forgiving of high earnings-multiple stocks
that have stumbled. That's why
Chipotle Mexican Grill (NYSE:
CMG
)
has seen its stock fall by $150 since mid-April. Or why shares of
Netflix (Nasdaq:
NFLX
)
are nearly $200 off of their52-week high . So it's the potential
downside, and not just capped upside investors need to be thinking
about.
There's no reason to anticipate a major blow-up for LinkedIn, as
we've seen with Zynga or Groupon -- it's a company providing a
worthwhile service to millions of users. Yet this good company is
now tied to an extremely richly-valued stock, and it's unclear how
much longer it can defy the laws of gravity.
-- David Sterman
David Sterman does not personally hold positions in any
securities mentioned in this article. StreetAuthority LLC owns
shares of GOOG in one or more if its "real money" portfolios.